What are Three Line Break Charts?
They are stock charts used in charting and study of chart patterns in technical analysis. They are trend following technique and are good in catching major portion of the trend.
This chart has its origin from Japan. These were developed in eighteenth century, to trade rice. Later on they were found useful in trading any other financial instruments. Just like in Kagi chart & Point and Figure chart and Renko charts, these charts also disregard the time factor in X axis.
These charts gets its name from the default number of line blocks typically used. They use an up block (line), a down block (line) and a reversal block (line). The size of the reversal block can be changed as per the trader's requirement.
You can get more detailed information about this charting technique in the book Beyond Candlesticks by Steve Nison.
To draw the blocks, today's close is compared to the high and low of the previous block. A block is drawn only when today's close exceeds the high or low of the previous block.
As long as the prices are moving up, an up block or a white (or blue) block is added in the next column if the price closes above the previous high. Similarly as long as the prices are moving moving down, a down block or a black (or red) block is added if the price closes below the previous low. If the prices does not make a new high or low, nothing is drawn.
A reversal block which signifies change in the trend, is added in the next column, only if the prices move against the current trend by a standard of three blocks. If the reversal is less than three blocks no change is done.
So any reversal block will be as big as the last three blocks of the previous trend. This allows to neglect smaller pullbacks. Of course the threshold for adding a reversal block can be changed as per the trader's requirement.
In an up trend, If today's close is higher than the top of the previous block, a new up block or white (blue or green) block is drawn in the next column from the previous high to the new high price. This addition of new up blocks is continued as long as the prices are making higher closes in the same direction.
No action is taken if the prices are not making new high or if the prices moves down, that is pull back in the opposite direction for less than the size of last three up blocks of the up trend.
If the prices reverses below the low of the last three up blocks of the up trend, a new reversal down or black (red or orange) block is added in the next column. It is drawn from the low of the last up block of the previous up trend to the low reached. Naturally it will be lower than the low of the last three up blocks.
Addition of new down or black (red or orange) blocks is continued as long as the prices are making new lower closes. A new down block is drawn in the new column from the low of the previous block to the new low reached.
No action is taken if the prices are not making new low or if the prices moves up, that is pull back in the opposite direction for less than the size of last three down blocks of the down trend.
If the prices reverses above the high of the last three down blocks of the down trend, a new reversal up or white (blue or green) block is added in the next column. It is drawn from the high of the last down block of the previous down trend to the high reached. Naturally it will be higher than the high of the last three down blocks.
With the default Three Line Break chart, a downside reversal occurs when the price moves under the lowest price of the last three consecutive white blocks. An upside reversal occurs when the price moves above the highest price of the last three consecutive black blocks. The size of the reversal block can be changed as per the trader's requirement.
Each column contain only one block – an up block, a down block, a reversal up block or a reversal down block. Reversal blocks are always longer than the last three blocks of the last trend.
Study the Three line Break chart given below and compare it with the bar chart.
This is a Three Line Break Chart. Compare it with the Bar Chart given below.
This bar chart is for comparison. It belongs to the same stock and time period.
There are many ways to trade with these charts. The most basic method involves buying when an up or white reversal block emerges and selling when a down or black reversal block appears.
An advantage of the Three Line Break chart is that there is no arbitrary fixed reversal amount. It is the market's action which gives the indication of a reversal. Buy or sell signals in these charts are given well after the new trend has started. Many traders prefer to enter the market only after the trend reversal has established rather than trying to pick a top or bottom.
To adjust the sensitivity of the reversal criteria, traders can adjust the number of blocks that need to be broken before a reversal block is drawn. Thus, two line or four line break charts can be used instead of the standard Three Line Break charts.
Shorter time frame traders should use shorter reversal amounts like two or three blocks, whereas longer term investors should use longer reversal amounts like five or even ten blocks. However the most popular line break chart in Japan is the Three Line Break chart.
There are many types of charts used in stock analysis. You may click on the name of each chart listed below to learn and understand more about them.